For Canadians looking to add international equity exposure, the days of thinking of emerging markets as one cohesive asset class are over.
The stark divergence in the stock market performances of BRIC countries in 2014 only reinforces this: The "BR" portion, Brazil and Russia, provided chilly returns, while Indian and Chinese equities soared.
Ayaz Ebrahim, chief investment officer of Asian equities ex-Japan for Amundi Hong Kong Ltd., is overweight these two outperformers, which are net importers of oil that stand to benefit from the collapse in prices.
"If you're at the race track, India is the horse that's the favourite, and has a high probability of winning in terms of getting a decent return," he said. "China's a bit of a dark horse – it has longer odds, but offers the chance of making a better return."
His optimism on India is informed by his faith in the country's leadership, Prime Minister Narendra Modi and Reserve Bank of India Governor Raghuram Rajan, whom he calls credible people who have the confidence of the markets.
The Prime Minister's laudable track record managing the state of Gujarat will carry over to the national level, he believes, though this task will surely prove to be more difficult.
While there has been little in the way of landmark reforms to attract foreign investment and improve the regulatory framework so far, Mr. Modi has made an important first step, according to Mr. Ebrahim.
The leader holds staffers to a more stringent standard, as is demonstrated through a commonly told tale in Indian media that the country's public servants no longer grace the greens of the Delhi Golf Club on a regular basis.
"Mr. Modi doesn't call them on mobile phones, he calls them on landlines to make sure they're in the office," he said. "The bureaucracy was inefficient, and by changing that he has laid down the foundation to move on to bigger things."
While Indian equities will be hard-pressed to match their blistering gains in 2014 of more than 30 per cent, Mr. Ebrahim expects a return of about 16 per cent this year, assuming no change in price-to-earnings multiples.
In his opinion, the two largest threats to the Indian growth story over the medium term are a spike in oil prices, which would take a bite out of domestic consumption and hurt the rupee, and the possibility that Mr. Modi becomes unable or unwilling to follow through on reform efforts, which would slow inflows of capital and leave domestic companies less keen on increasing investment.
For most investors the key question on China is, "Why buy now?" Years of rapid credit growth have fostered imbalances and the creation of excess capacity in the economy, and the rebalancing of growth toward domestic demand will not be without casualties.
Mr. Ebrahim has sympathy for this argument, and counts a brisk slowdown in economic activity as one of the biggest risks to equities across Asia given China's significant impact on its neighbours in terms of foreign direct investment, trade and tourism. However, he does not expect a hard landing for the Chinese economy, though some state-owned enterprises will indeed "fall off the wayside," as he put it. The fiscal and foreign exchange reserves of the government, as well as its power to force the banks to lend if need be, will ensure that the well-telegraphed moderation in growth does not morph into something worse, he thinks.
What's more, soured sentiment on the outlook for China may have created some can't-miss opportunities.
"For the banks, their book value clearly does not reflect their real value at the moment, but the big four banks are yielding 5.5, 6 per cent – for me, that's almost a no-brainer," he said.
In general, private-sector, consumer-oriented companies have better prospects for growth than the state-owned enterprises, the poster children for credit-fuelled troubles within the country.
Massive fluctuations in equity prices may leave some investors skittish about the Chinese market. The eye-popping rally in the Shanghai composite index in late 2014 can be attributed in large part to a tremendous surge in margin accounts – retail investors borrowing money to buy stocks. When Chinese authorities cracked down on this activity in January, equities retraced a portion of their still-impressive gains.
